Smart Investing: Earning 20% Returns On Your Money

Investing 20% of your income is a great way to build a strong financial foundation, especially if you're in your 20s. The earlier you start investing, the more you can take advantage of compounding gains, which can lead to significant growth over time. Setting clear financial goals is crucial, and it's important to understand the relationship between risk and return when making investment decisions. Creating a personalised investment plan based on your goals and risk tolerance is essential, and it's important to choose the right investment vehicles, such as stocks, bonds, mutual funds, or ETFs.

Save a large portion of your income

Saving a large portion of your income is a surefire way to build up your wealth over time. Here are some tips to help you save a significant chunk of your earnings:

Automate your savings

Setting up automatic transfers from your paycheck or monthly income to your savings account is a highly effective way to save without even thinking about it. By automating your savings, you remove the temptation to skip transferring funds to your savings, and it becomes easier to resist the urge to spend money instead.

Create a budget plan

Start by figuring out your monthly expenses. Record all your expenses, from daily purchases like coffee to regular monthly bills. Categorise these expenses, including utilities, groceries, transport, entertainment, etc. Once you know where your money is going, you can create a budget plan. A popular budgeting strategy is the 50/30/20 rule, where 50% of your income goes to necessities, 30% to wants, and 20% to savings and debt payments.

Cut down on non-essential expenses

Examine your expenses and identify areas where you can cut back. For example, you could reduce the number of times you eat out at restaurants or cook at home instead of ordering takeout. You could also cancel any subscriptions or memberships you don't use, especially those that renew automatically.

Focus on the "big three expenses"

The "big three expenses" are housing, transportation, and food. Keeping these expenses as low as possible will significantly impact your savings. For example, you could consider living in a smaller or less expensive home, using public transportation or a bike instead of owning a car, and budgeting a set amount for groceries each month.

Distinguish between "wants" and "needs"

It's essential to differentiate between what you want and what you need. By tracking your expenses, you can identify areas where you are spending money on wants rather than needs. This awareness will help you prioritise your spending and save more.

Resist the temptation to keep up with others

Just because your friends or peers are spending lavishly on certain things doesn't mean you have to. Be mindful of your financial goals and priorities, and don't feel pressured to spend money on things that aren't truly important to you.

By implementing these strategies, you can save a large portion of your income and work towards your financial goals, whether that's building an emergency fund, saving for a down payment on a house, or investing for retirement.

Invest in dividend stocks

Dividend stocks can be a great option for investors seeking passive income. Dividend stocks are shares in companies that regularly distribute a portion of their profits to shareholders. Dividends can be paid out annually, semi-annually, quarterly, or even monthly. Dividend stocks tend to be well-established companies with consistent profitability and a commitment to paying dividends in the long term.

To invest in dividend stocks, you simply need to own shares in the company, typically through a brokerage account or a retirement plan such as an IRA. Dividend-focused mutual funds or ETFs can also be a good option for investors seeking diversification and a more hands-off approach. Here are some key considerations for investing in dividend stocks:

• Company Background and Business: Research the company's history, business model, and financial health to assess the strength and durability of the company.
• Stock Price and Dividend History: Evaluate the current stock price and the company's track record of dividend payments, including frequency and amount.
• Financial Statements and Reports: Analyse the company's financial statements, annual reports, and investor presentations to understand their financial health and dividend policy.
• Media Coverage: Stay informed about the company's reputation and any news that may impact its performance and dividend payouts.
• Diversification: Diversifying your portfolio across different dividend-paying stocks or funds can help mitigate risk. Consider investing in a range of companies from various industries to lower the impact of any single investment.
• Dividend Yield: Assess the dividend yield, which is the cash payment you receive as a percentage of the stock price. A good dividend yield for income investors is typically considered to be between 3% and 5%.
• Payout Ratio: Examine the company's payout ratio, which indicates how much of its income is being used for dividend payments. A payout ratio above 80% may be a cause for concern, as it could indicate an unsustainable dividend policy.
• Tax Implications: Be mindful of the tax implications of dividend income. Dividends received in taxable brokerage accounts are generally taxed, while those received in tax-advantaged accounts like IRAs are not.
• Reinvestment: Consider reinvesting your dividends to increase your total investment return over time through compounding. However, keep in mind that share prices can fluctuate, so there is a risk that the value of your reinvested dividends may decrease if the share price falls.

• Verizon Communications
• International Business Machines
• British American Tobacco
• City of London Investment Trust
• Bankers Investment Trust
• Caledonia Investments
• BMO Global Smaller Companies
• Arbor Realty Trust Inc (ABR)
• AG Mortgage Investment Trust Inc (MITT)
• Franklin BSP Realty Trust Inc (FBRT)

Remember, investing in dividend stocks carries risks, and past performance does not guarantee future results. Conduct thorough research and consider seeking advice from a qualified financial professional before making any investment decisions.

Understand risk and return

When investing, it's important to understand the relationship between risk and return. While higher-risk investments can offer the potential for higher returns, they also carry a greater chance of loss. On the other hand, lower-risk investments tend to provide more stable, consistent returns but at a slower rate.

Risk and return are inherently linked, and it's crucial to assess your risk tolerance before investing. Your risk tolerance refers to the amount of risk you're comfortable taking on in pursuit of potential returns. It's influenced by various factors, such as your financial goals, investment horizon, and personal risk aversion.

By understanding your risk tolerance, you can make informed decisions about which investments to choose. If you're comfortable with higher risk, you may opt for investments like stocks, which have historically offered higher returns over the long term but come with greater short-term volatility. On the other hand, if you prefer lower risk, you might favour more stable investments like bonds, which typically provide consistent, steady returns with less fluctuation.

Additionally, diversifying your investments can help manage risk. By spreading your investments across different asset classes, sectors, and industries, you can reduce the impact of any single investment loss. Diversification is a strategy that can be applied across various investment types, including stocks, bonds, and other financial instruments. It's important to note that while diversification can help manage risk, it doesn't guarantee a profit or completely eliminate the risk of loss.

When assessing risk and return, it's also crucial to consider your investment horizon. This refers to the length of time you plan to hold an investment before selling it. Typically, longer investment horizons allow for greater risk-taking, as there is more time to recover from potential losses and take advantage of compound interest. In contrast, shorter investment horizons may require a more conservative approach to ensure capital preservation.

Choose the right investment vehicles

Choosing the right investment vehicle is crucial to achieving your financial goals. Here are some popular options for young investors, each with its own pros and cons:

• Stocks: Stocks typically carry more risk than bonds, but the level of risk varies depending on the sector, industry, and specific company. Over time, a buy-and-hold strategy can lead to substantial returns. However, with thousands of stocks available, this can be a daunting area for young investors.
• Bonds: Bonds offer low-risk access to the world of investing and often require less day-to-day management than stocks, although their payout potential is limited. A common strategy is to allocate a percentage of your portfolio to bonds that matches your age, so younger investors may opt for other options.
• Mutual Funds: Mutual funds are an excellent choice for beginners as they provide broad diversification and require minimal trading and oversight. They are well-suited to a buy-and-hold strategy, but the returns tend to be modest.
• Exchange-Traded Funds (ETFs): ETFs are a popular choice for both new and seasoned investors. They are baskets of securities, offering a one-stop-shop approach for those who don't want to manage individual stocks. ETFs provide a range of risk and return profiles, allowing you to tailor your strategy to your risk tolerance.

When selecting an investment vehicle, it's important to consider your risk tolerance, investment goals, and time horizon. Diversification is also key to ensuring your portfolio can withstand market volatility.

Start investing early

Starting to invest early is one of the best ways to see solid returns on your money. The earlier you start, the more time your investments have to grow through the power of compound earnings. This means that your investment returns start earning their own returns, allowing your account balance to snowball over time.

For example, if you invest $200 every month for 10 years with a 6% average annual return, you'll have $33,300 at the end of the 10-year period. Of that amount, $24,200 is money you contributed, and $9,100 is interest earned on your investment.

Starting early also means you have more time to weather the ups and downs of the market and reduce risk. You'll have fewer financial commitments, so you can save more. Additionally, investing early can help you build a bigger portfolio at a fraction of the cost compared to starting later.

For instance, if you invest $100 a month for the next 10 years and then never invest again, you could still earn more over the next 50 years than if you had waited 10 years to start and then invested $100 a month for 40 years. In this example, investing early results in an extra $19,961 for the investor who started early and spent less.

It's a common myth that you need a few thousand dollars to begin investing. In reality, it's beneficial to start investing early, even with a small amount like $100 a month, rather than waiting until you have a larger sum saved up. You can always start with a manageable amount given your financial situation and goals and then increase your regular contributions over time.

There are plenty of investment options available for those who want to start investing early, such as index funds, exchange-traded funds (ETFs), and mutual funds, which often have low or no investment minimums. Many new investors start with mutual funds and ETFs since they require smaller investment amounts to create a diversified portfolio.

Frequently asked questions